Retirement spending declines--- and that’s not a disaster.

Oct 12, 2016

Article By: Scott Burns

Q. My question concerns the assumption most planners make that retirement spending increases about three percent a year, no matter how advanced the client's age. I don't see how that is possible. My mother-in-law is 96. She is doing pretty well---she’s a true sweetheart. Her spending is definitely not increasing at three percent a year. What do you think would be a good Couch Potato rule that might apply to, say, age 85 and above- if the good Lord allows one to have that type of longevity? ---H.S., Dallas, TX

A. Good question, but I can’t give you an exact answer. I hope you haven’t met many financial planners who use a three percent assumption for future spending growth in retirement. If they do, it suggests that they aren’t keeping up with the many articles on the subject in both academic research and practitioner-oriented publications like the Journal of Financial Planning.

Multiple researchers, for instance, have used the Consumer Expenditure Survey, a regular exercise done by the Department of Labor, to identify how our spending changes over time. Spending in retirement is definitely not a “one-size-fits-all” deal.

In general, household spending peaks in our fifties. Then it slowly declines. Older people eat less and drink less. They also spend less on clothing and a wide variety of other things. There is a reason television advertisers are keen on attracting young people rather than old people. Younger people spend more.

While medical expenses do rise over time, decreases in other spending more than offset it for most people. Medical spending, however, is like playing poker with an increasing number of wild cards: the older you are, the greater the odds a health event will create a major expense.

If you Google the name “Ty Bernicke” you’ll have the start of a basic reading list, including a column of mine from 2005. If you want a deep look that is rich in links to supporting information, read the article on that Google list by financial planner Michael Kitces. He is one of the bright lights in practical financial planning.

Q. During the first Presidential debate, Donald Trump brought up the political bias of the Federal Reserve in general and chairperson Janet Yellen in particular. My question: What is the impact of the Fed’s efforts to keep interest rates low? I believe that the Fed causes the Treasury to issue financial instruments at yields that are below market rates.

The result is that someone will own assets that will be devalued when market rates increase above the rates the instruments were sold at. Who is obligated to cover the difference? What will be the impact, if any, when this difference is “called”? ---B.O., Austin, TX

A. The impact of ZIRP (zero-interest-rate-policy) depends mostly on whether you are a regular borrower of money or a regular lender of money. Low rates do wonders for the cost of government debt, so the U.S. Treasury is a big beneficiary. So are people who borrow to buy major assets like cars and homes. They can buy more car, or more house, with a given amount of income. Credit card borrowers don’t do as well.

Another beneficiary is any person, corporation, state or local government with debt that can be refinanced to a lower interest rate. And, finally, the owners of common stock benefit because people pay more for a dollar of corporate earnings when interest rates are low than when they are high.

The situation is just the opposite for a person or institution that counts on investments to provide a yield. The cost to private and public pension plans is enormous because it requires more money to finance a given amount of pension as interest rates sink.

The same is true for insurance contracts that depend on investment yield— that would be things like long-term-care insurance and life annuities. As interest rates decline, life annuity payouts become less and less attractive. Similarly, the lower yields go, the more companies that issue LTC policies have to raise their policy premiums.

There have been estimates of costs, but the true cost will only be known when interest rates return to “normal” levels. No one is expected to cover the difference. So expect a lot of train wrecks.

The economic phrase for what is being done by governments around the world is “financial repression.”

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